- 2-day FOMC meeting begins today with an assured rate hike
- U.S. CPI expected to reach 6-year high
- Treasury concludes coupon package by selling 30-year bonds today
- Italian stock and bond prices rally after Italy’s finance minister reaffirms the euro
2-day FOMC meeting begins today with an assured rate hike — The market is unanimously expecting the FOMC at its 2-day meeting that begins today to raise its funds rate target range by +25 bp to 1.75%/2.00%. That would be the second rate hike of the year following the March rate hike. The FOMC since Dec 2016 has followed a pattern of raising its funds rate target by +25 bp at every other meeting when there is a Fed Chair press conference, except for one meeting in Sep 2017 when the Fed left rates unchanged.
After this week’s meeting, the market is discounting the odds at 92% for the Fed’s third rate hike of the year in another two meetings on Sep 19-20. The market is then discounting the odds at about 50% for a fourth rate hike of the year at the final meeting of the year on Dec 12-13.
Market expectations are fairly close to the Fed-dot forecasts through the end of this year. However, the market is then more dovish than the Fed-dots starting in 2019 with the market expecting only about two rate hikes to 2.63% versus the Fed-dot forecast for three rate hikes to 2.90%. The market is not expecting any rate hikes in 2020. The market is expecting the funds rate to stabilize near 2.75% in 2020 and beyond, whereas the Fed is expecting the funds rate to reach a high of 3.40% in late 2020.
Fed Chair Powell in his post-meeting press conference tomorrow is not likely to indicate any intent by the Fed to accelerate its rate hikes in response to the tight U.S. labor market and near-target inflation. Instead, Mr. Powell is likely to reiterate the Fed’s intent to raise rates slowly. The Fed needs to tread carefully on raising rates since it is also tightening its monetary policy by slowly reducing its balance sheet. In addition, there are some cautionary factors for the global economy including (1) trade tensions, (2) rising inflation due to stronger commodity prices and higher wages, and (3) emerging market stress tied to rising U.S. interest rates and the stronger dollar.
U.S. CPI expected to reach 6-year high — The market consensus is for today’s May CPI to move higher to +2.7% y/y from April’s +2.5% and for the core CPI to edge higher to +2.2% from April’s 2.1%. Today’s expected headline CPI report of +2.7% y/y would match the 6-year high that was originally posted in Feb 2017. Today’s expected core CPI of +2.2% would be a 15-month high. The higher CPI figures will encourage the Fed to proceed with its steady rate hike regime without delay. The Fed needs to at least get the funds rate above its 2% inflation target and closer to a neutral rate in the area of 2.75-3.00%.
U.S. inflation has moved higher in the past several months due to (1) higher energy prices, (2) higher metal prices due to sanctions and tariffs, (3) higher prices on imported goods that are subject to new tariffs from the Trump administration, and (4) higher wages and higher input costs in general for businesses.
The CPI is running substantially hotter than the Fed’s preferred inflation measure of the PCE deflator. Nevertheless, even the PCE deflator has also been moving higher and is close to the Fed’s +2.0% inflation target. The PCE deflator in April was right at +2.0% y/y and the core PCE deflator was just slightly lower at +1.8%.
Treasury concludes coupon package by selling 30-year bonds today — The Treasury today will sell $14 billion of 30-year bonds, concluding this week’s $68 billion note and bond package. Demand was solid for Monday’s sale of 3-year and 10-year T-notes, which bodes well for today’s 30-year bond auction.
Today’s 30-year T-bond was trading at 3.09% in when-issued trading late yesterday afternoon, which is a relatively high level that is just 11 bp below the late-April 3-3/4 year high of 3.20%. Today’s 30-year bond auction will be the first reopening of the 3-1/8% bond of May 2048 that the Treasury first sold in May. The $14 billion size of today’s 30-year auction is $1 billion above May’s auction and is $2 billion above the $12 billion reopening size that prevailed during 2016-17.
The 12-auction averages for the 30-year bond are: 2.38 bid cover ratio, $5 million in non-competitive bids to mostly retail investors, 4.8 bp tail to the median yield, 42.2 bp tail to the low yield, and 32% taken at the high yield. The 30-year is slightly below average in popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 62.7% of the last twelve 30-year bond auctions, which is mildly below the median of 63.5% for all recent coupon auctions.
Italian stock and bond prices rally after Italy’s finance minister reaffirms the euro — Italian stock and bond prices on Monday surged after Italian Prime Minister Tria said that there has been “no discussion” within the government of any proposal to leave the euro and that the government would fight any negative market conditions that could “push towards an exit.” He also suggested that the government will seek to boost the economy through structural reforms rather than simply deficit spending. He said that financial stability will be part of the government’s plan. He also downplayed the possibility of issuing mini-BOTS to cover the government’s current short-term IOUs, which the market has feared could act as a parallel Italian currency of sorts.
The Italian 10-year bond yield on Monday fell sharply by 29 bp to 2.83% and the 10-year Italy-German spread fell by -34 bp to 234 bp. The iShares Italy stock ETF on Monday rallied sharply by +3.75% to a 2-week high.